Q1 18 Review: A Return Of Volatility And A Time To Revisit Strategy

After a lengthy snooze, market volatility resurfaced in Q1. The year started off hot. US stocks rose 5.2% in January and extended the S&P 500’s all-time record for consecutive positive months to 15. But February began with a sharp drop that barely dipped into 10% correction territory. In the end, the ups and downs roughly balanced out. The Total US Stock Market finished down -0.7% for the quarter.

It is hard to pinpoint a single culprit for the abrupt end to the market’s goldilocks phase. Initial declines began with news of stronger than expected economic data, which is usually a positive for stock prices. This time, it stoked fears of higher interest rates and/or inflation. Market losses then accelerated rapidly when a number of similarly positioned hedge and quant funds were forced to reduce bets for continued low volatility. Not surprisingly, stocks initially bounced back from this temporary pressure, but have remained choppy ever since.

The return of volatility can feel jarring after two years of hibernation, but ups and downs in equity investing are normal and healthy. Without short-term risk, the critical long-term wealth creation from stocks would not be possible.

In recent weeks, solid economic fundamentals and corporate earnings growth are playing tug-o-war with fears of Fed rate hikes and protectionist policies. President Trump’s tariffs and the sudden departures of economic advisor Gary Cohn and Secretary of State Rex Tillerson make for great headlines of trade wars to come. Maybe. But Trump takes pride in his negotiating skills and it is difficult to differentiate between what is real and what is simply posturing. It is not uncommon for the current administration to start with an extreme position and then compromise back toward the middle. Widespread protectionism could be serious, but what has been enacted so far is not big enough to dent the global economy.

Looking Ahead

Stock valuations remain high by historical standards, but not excessive. Sentiment is a mixed bag. Things like Bitcoin’s meteoric rise and the FAANG acronym becoming a household term suggest high-level sentiment has shifted from fear of losing money to fear of missing out. The global economy continues to power ahead. US GDP growth has hovered around 3% for the last few quarters while growth overseas is accelerating toward 3%, according to World Bank forecasts. Putting it all together, now is not the time to be greedy. It is also not the time to panic. Over the long-term, stocks go up more often than they go down. Those with a thoughtful long-term investment strategy should feel confident regardless of short-term gyrations.